Firms that will be affected by the revised Markets in Financial Instruments Directive (MiFID 2) are probably tired of hearing exhortations from their regulators and advisers to start planning for MiFID 2 implementation. Everyone breathed a sigh of relief when the implementation date was delayed by a year, although there were stark warnings that the delay was because an extra year’s preparation time was needed. While firms had a reason to relax for a few months, maybe, while the European Commission and the European Securities and Markets Authority (ESMA) progressed level 2 legislation and technical standards that would provide more certainty as to the impact of the changes, there is no longer any leeway for relaxation. The changes (well, almost all the changes) will take effect on 3 January 2018. In the UK, changes to legislation are nearly finalised, changes to regulatory requirements are under consultation, and the Financial Conduct Authority (FCA) has now issued its guide to applications and notifications and opened its application window. Firms that have not made complete relevant applications by the beginning of July risk not having the right permissions in place come 2018. In this article, Emma Radmore and Andrew Barber focus on the changes that will impact investment advisory and wealth management firms. We do not look at the changes trading firms face to the transparency and transaction reporting requirements.
The Brexit effect
Two golden rules apply:
- The UK is implementing MiFID 2 and UK firms must comply with it: The Government has been clear in all communications that the UK will fully implement and comply with all EU legislation until it is no longer a Member of the EU. Regardless of the results of current domestic wrangles, and the timing of the Article 50 notification, we must assume the UK will still be an EU member in January 2018. So Treasury and FCA (and the Prudential Regulation Authority (PRA), for dual-regulated firms) have been consulting, and continue to consult, on necessary legislative and regulatory changes
- Brexit is coming: That said, Brexit will happen, and we will not know for some time what agreement may (or may not) be reached between the EU and the UK for UK firms to do business in or into the remaining EU and vice versa. What is clear, though, is that the UK has no interest in pursuing a membership of the European Economic Area. As a result, there is no possibility that the “single passport” can continue in its current form, whatever may be agreed to take its place. So some aspects of MiFID 2 implementation will inevitably be comparatively short-lived.
Permissions and passports
FCA released its guide on application and notifications under MiFID 2 in January. The guide is widely relevant – and is not restricted to firms that will be seeking authorisation for the first time:
- All firms that are already authorised will need to consider whether they will carry on any activities in relation to any instruments that will bring them within the scope of being a “MiFID investment firm” when they are not currently such a firm
- Any firm that is currently an “article 3 exempt” firm (that is, a firm whose activities are limited to arranging and advising and which does not hold client money), will need to consider whether it wishes to remain exempt
- Firms that already carry on business that does not currently require authorisation (such as high frequency traders) but which will now be a regulated activity will need to apply for authorisation
- Firms that are considering a restructuring which involves a change of legal status for an authorised firm must be aware that the new entity will need to apply for a full new authorisation.
Any firm that needs to make an application for a new authorisation, or for a variation of permission (VOP) that will make it a MiFID firm, should be doing so now. Any firm applying for a VOP to make it a MiFID firm needs also to be aware that there are new Forms A that must be submitted in respect of new recruits who will be performing controlled functions covered by MiFID 2 (that is, members of the management body and others who effectively direct the firm’s business). Other new recruits will complete the existing Form A.
MiFID 2 also presents an opportunity for firms to consider whether:
- They need all the permissions they currently hold (particularly, now, in relation to Treasury’s decision to amend the need for permission for investment advisory activity – although FCA has not made the necessary changes to its rules yet to take account of this)
- Their permissions cover the correct client types (given that some professional clients may now need to be treated as retail, and that some business that can currently be treated as ECP business will no longer be able to be categorised as such)
- They need all the passports they currently hold, or will need more to enable them to passport any of the new investments and services MiFID 2 is bringing
- They need to make notifications to FCA to benefit from the transitional arrangements relating to structured deposits (rather than applying for a VOP, which they will need to do if they do not make the notification in time).
Onboarding process and client disclosures
Firms will need to review their onboarding processes as part of their implementation of the fourth Money Laundering Directive (MLD4) – which should be implemented by late June, although the legislation and regulatory guidance are not yet available even in draft, so this creates a significant timing issue. As part of the review, it would make sense now to consider the implications of MiFID 2.
Most of the changes discussed below will apply to all business covered by FCA’s Conduct of Business Sourcebook (COBS), regardless of whether it is MiFID business or not.
For most firms, client categorisation will be unaffected. However, there are changes that may have a significant impact on some businesses:
- Some local authorities that are currently treated as professional clients may either now have to opt-up to be treated as professionals, or will need to be treated as retail (which, in turn, may mean that some firms either need to vary their permissions or will no longer be able to deal with these clients)
- Elective professional clients will no longer be able to opt up to ECP status, and there will be additional procedural requirements for per se professionals who are opting up.
Generally, firms that deal with ECPs should also note that a greater number of conduct of business requirements will apply to ECP business under MiFID 2.
MiFID 2 improves and increases disclosures for both retail clients and, in particular, non-retail clients. All firms are likely to have to make changes to the information they provide to clients at the outset of the client relationship. Depending on the client base and the extent to which the firm currently exceeds what is technically required, particularly for professional clients, there will be a need to draft compliant documentation and ensure it will be properly used.
Where firms provide advisory services, the disclosure requirements will potentially change significantly, to meet MiFID 2’s requirements on disclosure of services and charges.
Firms will now have to provide client agreements for professional as well as retail clients and, although most firms will already be doing this, they will need to ensure their agreements address the information MiFID 2 requires,
Charges and Commissions
MiFID 2 makes fundamental changes to the charges and commissions firms can make and receive, and how they disclose them to customers. To a large extent, the UK has mainly moved ahead of MiFID 2 in terms of both prohibited inducements and adviser charging under the Retail Distribution Review, but nevertheless firms must review their policies and procedures.
FCA plans to include the MiFID 2 inducement ban into its core inducement rules for MiFID, equivalent third country and article 3 firm business. It will transpose (but not extend) the MiFID 2 ban insofar as firms provide advice to professional clients – so these firms will need to make more adjustments than retail firms who are more used to the restrictions. For retail firms, the MiFID 2 ban will extend more widely than MiFID 2 requires, so it covers restricted advice and bans rebating of inducements.
For the MiFID 2 provisions on inducements and research, FCA has decided to move the existing provisions to another part of the Handbook, and to amend them to ensure MiFID 2’s aims are reflected.
FCA also proposes to apply the inducement ban to all advice, rather than just personal recommendations (although Treasury’s recent announcement on how it intends to address advice in future may affect this). Advice on structured deposits will be subject to the inducement ban, but not to the RDR adviser charging rules. More generally, MiFID 2 is prescriptive about the way in which firms disclose information about themselves, their services and their costs and associated charges, which will require all firms to reassess and re-present their customer documentation.
MiFID 2 introduces a new standard for “independent advice” , which is similar to the UK Retail Distribution Review (RDR) regime but is not the same. FCA’s current plan is to implement the MiFID 2 independence standard for personal recommendations to retail clients that relate to MiFID 2 financial instruments and structured deposits and to non-MiFID products that are “retail investment products” under current FCA rules. In principle, it is also likely to apply these standards to advice that falls outside MiFID 2 scope. On the whole, firms are unlikely to need to make significant changes, but some may need to consider their organisational requirements in light of the MiFID 2 ban on individual advisers from providing both independent and non-independent advice. There are further requirements on firms to ensure suitability of personal recommendations, which will be mandated in FCA Rules through a copy out of the relevant MiFID 2 delegated regulation text. On a related issue, and where firms are not providing a personal recommendation, they will need to assess whether any products they currently exclude from the appropriateness assessment on the grounds they are “non-complex” can still benefit from this, as MiFID 2 has narrowed the scope of products that can be categorised in this way.
Dealing and managing
MiFID 2 brings further refinements to the requirements on execution, which means firms will need to update their execution arrangements and policies, and the way they monitor them. Firms will also need to update their systems and controls to meet the MiFID 2 record keeping requirements on client orders, decisions to deal, transactions and order processing.
Firms that underwrite and place will also need to set up specific new compliance measures to ensure compliance with MiFID 2’s provisions, particular on conflicts of interest and disclosure.
Although FCA introduced a recording requirement some time ago, firms will need again to make changes to ensure they meet the MiFID 2 retention requirement (5 years), and the increased scope of the requirements in terms of clients, transactions and products.
Firms will need to assess their current policies and procedures on reporting to clients, to ensure they comply with the MiFID 2 requirements on timing and content of reports.
This article does not address other changes firms will need to consider, for example:
- Agreements between product providers and distributors to comply with MiFID 2’s product governance requirements
- Changes to training and competence arrangements – among other things, MiFID 2 applies requirements to those who advise professional clients, not just retail
- Approved persons – there will be new forms A for MiFID firms going forwards (as noted earlier in this article)
- Client money: MiFID 2 tightens governance rules around client money. Again, FCA rules already go a long way towards meeting MiFID 2, but firms will nevertheless need to review their policies and procedures, not least where they use Title Transfer Collateral Arrangements for non-retail clients, which they must now show are appropriate
- Systems and controls generally: FCA consultations have suggested several changes to the Senior Management Arrangements, Systems and Controls (SYSC) sourcebook, many of them minor, but some relatively minor changes may have significant effects on some firms
- Compliance arrangements: firms will need to ensure that their compliance, risk management and internal audit functions meet MiFID 2 requirements.
The key message
MiFID 2 means change to significant parts of the UK legislative and regulatory structure. Some firms will be affected more than others. The effects will depend on the type of firm, its client base, the services it provides, the products it deals in, its current policies and procedures, and many other factors. But no firm will be unaffected and many changes cannot be implemented overnight. Any firm that has not by now produced its gap analysis and action plan may struggle to ensure it is compliant with MiFID 2 in time for January 2018.
This article was originally published by Law360.com